CCI Trading System

  

The Commodity Channel Index, also known as CCI, is an oscillator designed to spot cyclical trends in financial instruments.

Initially, it was used for commodities price analysis, as its name suggests.

Donald Lambert designed this indicator and published it in his book, “Commodities Channel Index: Tools for Trading Cyclical Trends.”

As many other oscillators, the CCI has a centerline and its values can be either positive or negative, above and below this zero value line.

CCI is an unbounded indicator, which means that neither the positive nor the negative values have a theoretical limit.

The price evolution determines the CCI value to oscillate above and below the zero line and its unbounded nature makes this indicator a good candidate for momentum trading.

With a default period of 14, the CCI indicator can be tweaked to be more or less responsive.

Its sensitivity to sudden price movements is a function of the period value.

The greater the period, the less sensitive it will be and fewer signals it will generate.

The smaller the period, the more sensitive it will become and more signals it will generate.

This way we can test and pick the right value for the financial instrument and the time frame we need to trade on.

Notice how the CCI indicator is oscillating above and below the zero line level and is crossing it more times on the smaller period chart (6) and fewer times on the bigger period chart (50).

On the same chart, we can also notice that the indicator is crossing the other two levels many traders consider important: the 100 and the -100 levels.

When it comes to oscillators in general, terms like “overbought” and “oversold” are often used.

The overbought condition of a market is in this case considered to be one that has the value of the CCI over 100 and the oversold condition of the same market is considered to be that in which the indicator has values below -100.

Even though traders look at these two conditions as signals in and of themselves, whether it is a strong enough signal or not, remains to be determined.

CCI can be used in trend following systems and in mean reversion systems equally fine.

That being said, the signals will differ somewhat, because different markets behave differently.

For example, a prolonged evolution of the price that causes the CCI values to consistently remain above the zero level usually indicates a bullish momentum. The opposite is true for value below the zero level. In a trend following system, that’s enough to enter and stay in those positions until the trend gives signs of exhaustion or even reversals.

In certain markets, though, even if the CCI value is pushed above 100 or below -100, the price elasticity is bound to snap back and eventually revert to the mean. Traders that are familiar with said markets can feel which are the levels when or where that happens usually. Unsustainable momentum moves can break and reverse even from CCI values well over 100 or well under -100.

The CCI can be seen as a gauge that indicates how far the current price has moved from what’s considered to be the average price. If we think about the price as something that tends to evolve in a channel with a somewhat natural oscillation range, the CCI is designed to signal the anomalies that happen in markets where unseen forces are pushing the price out of that natural oscillation channel.

Whether we choose to go with the flow and get in trending moves, or we choose to wait for the market to get exhausted and fade the impulsive move, CCI can be equally useful.

 

CCI Formula

The CCI aims to determine overbought and oversold conditions measuring the relationship between the price and its moving average (MA).

This is what’s happening behind the curtain:

CCI = (Typical Price – Simple Moving Average) / (0.015 x Mean Absolute Deviation)

One critical component that determines the CCI’s value is the time interval and modifying this can improve the responsiveness of the CCI.

Because the CCI tries to forecast a cycle using moving averages, the smoother the moving average is, the more precise the signal will be.

 

Basic CCI Signals

The Commodity Channel Index (CCI) can work as a leading or as a trending indicator.

As a leading indicator, traders can look for overbought or oversold market conditions that in turn may indicate a possible mean reversion.

In the role of a trending indicator, the CCI can give traders signals that new trends are about to start.

They look out for spikes above +100 as an indication of a possible start of a bullish trend.

Values below -100 usually are associated with weak price action and suggest a possible start of a bearish trend.

 

CCI New Trend Catching

Most of the time, CCI has values between -100 and +100. Therefore, when it gets out of that range, that can be proof that exceptional strength or weakness was spotted in the market. This range may act as a filter in trend following systems and who’s in control of the price evolution becomes evident once the price causes the CCI to get out-of-whack.

Because in ranging markets it’s pretty common to see many crosses of the zero line, acting only on strong signals may be advisable to avoid the whipsaws.

Getting in trades later, rather than sooner, may introduce lag, but may also save some money and keep the frustration at bay in indecisive markets.

In any case, the CCI is not a top or a bottom finder, by any means. If that’s the intended use, it may be coupled with other trading tools and CCI can be used as a filter to cut the noise and focus on the bigger trend.

 

CCI Overbought and Oversold Trading

As with any other oscillator, the terms are somewhat misleading, in the sense that yes, the market can get even more overbought or oversold, even though it just crossed our line in the sand, so to speak.

By definition, momentum implies energy and unless the energy is spent, the move can and often will continue in spite of our predictions.

Because CCI is an unbounded indicator, the limits we observe are relative, therefore, less than reliable.

In addition, any financial instrument can continue to go higher following our overbought assessment, or it can continue to go lower following our oversold assessment.

In some markets -100 to +100 range works well enough, other markets can produce more impulsive moves where -200 to +200 levels can be attained or even surpassed.

Market observations and trader experience are important in determining whether CCI is the right tool for that respective job or not in that particular market, at that particular time, especially in mean reversion systems, which are notorious for being moodier and more difficult to implement.

 

CCI Divergence Trading

A possible reversal point can also be spotted by hunting down divergences.

Those are the rare occasions seen on charts where the oscillator readings and the price itself seem to tell different stories.

If the directional momentum does not confirm the recent price movement, many traders usually take notice.

Bullish divergence takes place when the price plots a lower low and the CCI forms a higher low.

Bearish divergence happens when the price plots a higher high and the CCI forms a lower high.

Spotting divergences do not work as crystal balls, either. They are not the perfect reversal spotting sauce, and they can be misleading, especially during strong trends.

A strong trend may reveal a lot of bearish divergences before a top actually settles in place. Conversely, bullish divergences tend to occur during extended downtrends.

Confirmation is critical to any divergence and CCI makes no exception.

Divergences usually reveal a change in momentum and that can come before a trend reversal, but the confirmation is actually on the chart itself.

When a strong support level breaks or CCI level goes negative, a bearish divergence can be confirmed.

On the other hand, a bullish divergence is confirmed when a strong resistance level gets broken or CCI goes positive.

 

 

Price forms a higher high, while the CCI indicator forms a lower high, then break the zero level to the downside.

 

CCI Trading for Scalpers

As a short-term trading system, any scalping strategy tends to work better if we stay out of the long-term trend’s way and in tune with the short term one also.

A relatively long period moving average can help us stay on the right side of the market when it comes to the long-term trend.

The CCI can then be used to spot opportunities on the short-term realm.

The 100 EMA and the 14 period CCI tandem should do the trick.

We can look for sell trades if the price stays below the moving average when the CCI drops below -100 level.

If the price rises above the moving average and the CCI gets buoyant above the +100 level, we may consider buying.

 

CCI Trading for Daytraders

Signals given by the CCI indicator can be successfully used on a daily basis as they come, but additional filtering will make them even more reliable, provided the periods of the indicators are in tune with each other.

A cross of the 100 level on the upside can be the signal for a long entry in which we may choose to remain until the price determines the CCI to go negative.

As a bearish signal, the -100 level crossing can be a valid signal and we may consider keeping the position until we cross back onto the positive domain.

What makes the CCI a good day trading indicator is simply the fact that it is a momentum indicator by definition. In many markets, we may witness at least one strong impulse most of the days. Traders can capture at least part of that energy if obvious signals are not ignored.

 

CCI Trading for Swing Traders

Market cycles on longer than one-day trades involve more patience and way more trust in the tested strategies traders employ.

That’s why second-guessing is not what swing traders do and that’s why swing trading systems usually involve more than one signals or indicators that need to corroborate their stories.

Coupled with other trading tools, the CCI can filter out some noise and help pick an entry close enough to a new beginning of a trend, not necessarily a top or a bottom, especially on timeframes higher than H1.

The CCI is not a stand-alone swing trading indicator precisely because it is a momentum indicator par excellence. It is better at showing when the market is trending than it is at showing when the market is about to stop or it just stopped trending, being a moving average based indicator, therefore lagging by design.

 

Conclusion

CCI is one versatile trading tool, without any doubt.

Ultimately it’s up to the trader to tweak it and use it as the fine tool that it is.

There are no universal recipes and seldom we’ll find one system that fits all markets all the time, if ever.

CCI makes no exception and whether we choose to use it in trending, ranging, volatile or any other kind of markets, it is one tool worth knowing how to use.